Understanding the Over 65 Tax Exemption and Proration in Texas Real Estate

The Over 65 Tax Exemption is a significant benefit for Texas homeowners aged 65 and older, providing a considerable reduction in annual property taxes. This exemption is based on the property's status as of January 1 of the tax year. While advantageous for qualifying homeowners, the exemption introduces unique challenges during property sales, as buyers may not qualify for the same exemption. Negotiating tax proration in such cases requires careful consideration to ensure a fair outcome for both the buyer and the seller.

How the Over 65 Exemption Impacts Tax Proration

In Texas, property taxes are typically prorated at closing to account for the portion of the year each party owns the property. When a seller benefits from the Over 65 exemption, their property tax rate is lower than it would be without the exemption. This creates a potential discrepancy when the property transfers to a buyer who may not qualify for the exemption. Without an agreement on how to handle this disparity, one party could bear an unfair share of the tax burden.

For example, if taxes are prorated with the seller’s exemption, the buyer might face a higher-than-expected tax bill after closing. Conversely, if taxes are prorated without considering the exemption, the seller might pay more than their fair share at closing. Resolving this issue requires a mutual agreement between the buyer and the seller, facilitated by the title company.

Common Methods of Tax Proration

Title companies generally rely on one of three methods to prorate taxes when the Over 65 exemption is involved. The first method calculates taxes without the exemption, reflecting the likely tax liability for the buyer after the sale. The second method uses the seller's exemption to calculate prorations, which aligns with the seller's reduced tax rate. A third, more flexible approach involves the buyer and seller negotiating a mutually acceptable amount that accounts for both parties' interests.

The method selected can significantly affect the financial outcome for each party. Prorating without the exemption protects the buyer from unexpected tax increases but may increase the seller's costs. Prorating with the exemption benefits the seller by lowering their closing costs but can leave the buyer with an unanticipated financial burden. In balanced markets, a negotiated compromise is often the best solution.

Negotiating Tax Proration: Buyer Strategies

For buyers, prorating taxes without the exemption is generally the most favorable option. This approach ensures that they are not held accountable for a tax reduction they cannot claim after the sale. Buyers should advocate for this method by highlighting the risks of supplemental tax bills, which can occur when the exemption is removed after closing. This is especially important if the buyer does not qualify for the Over 65 exemption and faces a substantially higher tax rate.

When negotiating, buyers can strengthen their position by providing evidence of the potential tax liability post-closing. Buyers should also be prepared to compromise if the seller is reluctant, particularly in competitive markets where sellers have more leverage.

Negotiating Tax Proration: Seller Strategies

Sellers benefit most from prorating with their existing exemption, as this reduces their financial obligation at closing. Sellers should argue that property taxes are calculated based on the property's status as of January 1 and that they should not be penalized for the buyer’s inability to qualify for the exemption.

To support this argument, sellers can reference the market standard and provide data showing that prorating with the exemption is a common practice. They can also emphasize the importance of a timely and smooth transaction, suggesting that prorating with the exemption simplifies the process and avoids additional negotiations.

Risks and Considerations for Both Parties

Prorating taxes without the exemption can be challenging for sellers, particularly if the difference in tax liability is substantial. This approach may also deter sellers in a competitive market, where buyers are expected to make strong offers. On the other hand, prorating taxes with the exemption places a significant risk on buyers, who may receive a supplemental tax bill for the increased liability after the exemption is removed.

Both parties should consider the impact of these risks and weigh them against the benefits of reaching a fair and equitable agreement. In cases where the difference in tax liability is extreme, a middle-ground solution is often the most practical approach.

The Case for a Split Agreement

In many transactions, the most equitable solution involves prorating taxes based on an amount between the with-exemption and without-exemption calculations. This approach balances the interests of both parties, ensuring the seller does not overpay while protecting the buyer from unexpected costs. A split agreement can also expedite the closing process by reducing the likelihood of prolonged negotiations.

Title companies often recommend this method when the parties struggle to reach an agreement. By sharing the financial burden, both the buyer and the seller demonstrate a willingness to cooperate, fostering goodwill and reducing the potential for disputes.

Practical Scenarios for Choosing Each Method

The decision to prorate taxes with or without the exemption, or to negotiate a split agreement, depends on several factors. Buyers should prioritize prorating without the exemption if they cannot qualify for it and if the market conditions allow for buyer-favorable negotiations. Sellers should push for prorating with the exemption when they hold leverage in the transaction, such as in a strong seller's market or when the buyer is highly motivated.

A split agreement is particularly beneficial in balanced markets or when both parties value a collaborative approach. It is also wise when the difference between the with-exemption and without-exemption tax amounts is substantial, making a compromise more acceptable to both sides.

Understanding Title Company Roles and Contract Variations

The title company plays a critical role in facilitating tax proration. However, they can only act based on mutual instructions from the buyer and seller. Contracts, including the Texas Real Estate Commission's standard forms, provide a framework for handling tax proration but allow flexibility for negotiated solutions. Paragraph 13 of the TREC contract, for example, acknowledges that prorations may consider changes in exemptions and requires adjustments when the final tax statements are available. Buyers and sellers should carefully review these provisions and consult with their agents to ensure clarity and fairness.

FAQ

What happens if the parties cannot agree on a proration method before closing?

If no mutual agreement is reached, the title company may default to prorating without the exemption, which could disadvantage the seller. The title company may also  prorate it with the exemption. In rare situations, the title company could refuse to close on the transaction because it does not want to be involved in a conflict between the buyer and the seller. 

Can buyers apply for the Over 65 exemption after closing?

No, the exemption is tied to the individual property owner's qualifications. Buyers must meet the age requirement and other criteria to qualify for the exemption in subsequent tax years.

Why is a split agreement often recommended?

A split agreement reduces the financial risks for both parties, creating a fair compromise. This approach is particularly useful in transactions where neither party has a clear advantage​